COSTA RICA: Coping with the inflation challenge

CENTRAL AMERICA - Report 28 Jun 2022 by Fernando Naranjo and Felix Delgado

Costa Rica’s most important economic feature in the first two months of the new Rodrigo Chaves administration has been the challenge for Central Bank policies, due to mounting global inflation that has exceeded the upper bound of Bank targets, coupled with rising FX pressures. Although at first sight much of the CPI hike could be associated with rising U.S. consumer prices, and the effects of the Russia-Ukraine war, excess domestic liquidity must also be wiped out. The Bank adopted aggressive monetary measures and is analyzing other options in its arsenal. Growing external risks will likely have some depressive effect on foreign trade, and therefore on economic activity. But fiscal trends look positive and meeting the agreed-upon targets in the current IMF program does not seem to be at risk.

El Salvador has experienced few changes in political conditions since our last report. Criticism from human rights organizations about the exception status persist, while Congress has extended its authorization to continue using that status to fight gangs. The pension reform promised by the government for August 2021 is still pending submission to Congress. There are signs that the impending proposal will consider the current individual capitalization regime unsustainable. As we have mentioned in previous reports, returning to a PAYG system would alleviate the current financing constraint faced by the government. Investor confidence continues to fall, as reflected by the EMBI indicator. As will be the case for all Central American countries, existing external shocks will constrain economic activity. They’ll also be affected by atypically high inflation, and persistent fiscal unsustainability.

Guatemala’s economy is more resilient to the impact of external shocks than the other Central American countries. The country has demonstrated capacity in handling crises, such as the pandemic, and more recently in managing a less favorable than projected external outlook. To mitigate the impact of higher import prices and global economic slowdown, authorities have been proactive. On June 16th, the government announced a national emergency plan to alleviate the economic effects of the war in Ukraine. The outlook for the country remains positive, despite changes in recent months. As we pointed out in our April report, fiscal discipline and strong macroeconomic indicators make Guatemala attractive for investors. This will be a good year for economic growth, if less favorable than we expected a few months ago.

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